Despite expectations of further tightening, bruised dollar not finding support

January 15, 2018 10:49 AM

Many traders have been caught by surprise by the extent of the dollar’s decline over the last week. The USD Index fell below 91 for the first time since January 2015, and Friday’s 0.96% drop, was the second biggest since January 2017. More surprisingly, the U.S. data released over the last week certainly doesn’t justify a dollar selloff.

U.S. core consumer prices recorded their largest increase in 11 months in December, rising 0.3%. Retail sales for December rose 0.4%, whereas core retail sales increased 0.3% after an upwardly revised 1.4% surge in November. The two tier-one economic reports sent expectations for an interest rate hike in March to above 72% from just a 50% chance last month.  This clearly suggests that internal data did not inspire the dollar selloff, but rather, external developments played a role.

Given that the Euro holds the most weight in the dollar’s index, constituting about 57% of the weight, the single currency movement, spurred by political and monetary policy developments, is dictating the DXY’s direction. On the political side, the coalition deal between Angela Merkel and social democrats was a great relief, after nearly four months into Germany’s general election. More importantly, the shift in European Central Bank’s language is a new development sparked by hints that the Governing Council agreed to review its policy language early this year.

However, the hawkish comments recorded in the December minutes were made before the release of the Eurozone inflation which slipped further away from the Central Bank’s target ending the year at 1.4%. The ECB will meet in 10 days, and unless Mario Draghi finds a way to convince markets that the unwinding of stimulus will be very slow, I think the Euro will be marching towards 1.25 by end of Q1.

The Pound’s performance was also outstanding after British pound/U.S. dollar (GBP/USD) currency pair managed to break above the 1.3656 resistance level. Reports released on Friday that the Spanish and Dutch are willing to reach a soft Brexit deal helped to fuel the rally. The U.K. parliament will be meeting on Tuesday and Wednesday for another debate over Brexit, so a close eye should be kept on new developments. 

This week, inflation figures once again will be under the spotlight in the UK and Eurozone. I think if we get any surprise on Tuesday, it will be to the downside, so the rally in both currencies may pause. 

The Bank of Canada will also be under the investors’ radar as the central bank is expected to hike rates by 0.25% on Wednesday. This comes despite a lot of uncertainty towards the Nafta talks.

About the Author

Hussein Sayed is chief market strategist at FXTM.